I have a new publication in the journal Economic Analysis and Policy on the evolution of the RBA’s financial stability mandate and its relationship to the inflation target. Copyright restrictions prevent posting full text online, but DM if interested.

The ‘Lehman Moment’ that Wasn’t: Marking the Wrong Anniversary

My reflection on the 10th anniversary of the failure of Lehman argues that we are focused on the wrong anniversary. The failure of the Congressionally-mandated GSEs one week before should be the exemplar of the crisis.

Debate Papers: Will the global trading system survive President Trump’s tariffs

In the latest installment of the United States Studies Centre’s Debate Papers series, Alan Oxley takes the affirmative and I take the negative on whether the global trading system will survive President Trump’s tariffs.

Trump’s tariff war doesn’t play to America’s great strengths

I have an op-ed in today’s AFR on America’s move away from its traditional open door policy towards foreign investment. Text below the fold.

Recent volatility in US stock markets has been attributed to speculation about new restrictions on foreign investment in the United States. The Trump Administration has been sending mixed signals on the issue, but is likely to move away from what is still a relatively open foreign investment policy.

The Administration has considered invoking the International Emergency Economic Powers Act to impose blanket restrictions on foreign investment in sensitive sectors of the US economy. The US Congress is also considering legislation expanding the scope and powers of the Committee for Foreign Investment in the United States (CFIUS), a review body similar to Australia’s Foreign Investment Review Board.

Both measures target China’s systematic harvesting of technology through investments in US companies in support of Beijing’s ‘Made in China 2025’ initiative. China aims to become a world leader in key technologies, including robotics and artificial intelligence, many of which have both civil and military applications.

The US correctly sees China as pursuing a mercantilist approach to economic development through state industrial policies that discriminate in favour of Chinese firms and which may harm US national security.

The US concern over China’s systematic, state-sponsored theft of foreign technology is a legitimate one, but increased restrictions on foreign investment may not be the right way to tackle the problem. There are alternative, more targeted policy instruments that can be used.

The US has an export control regime that regulates the export of sensitive technologies that is already being expanded in legislation before Congress.

The US can initiate further World Trade Organization disputes in concert with other countries to address China’s violations of the Trade-Related Investment Measures and its own WTO Accession Protocol, which prohibit requiring technology transfer as a condition for market access.

The US could also adopt targeted sanctions against Chinese companies engaged in intellectual property theft and impound Chinese imports found to have infringed intellectual property rights.

By contrast, limiting Chinese investment in the United States could backfire by encouraging China to double-down on its indigenous innovation strategy. The recent US sanctions against ZTE have already spurred China further down this path. If Chinese capital stays at home, it is more likely to finance Chinese innovation at the expense of the US and other US-allied economies.

Failing to capitalise on Chinese investment may hinder the development of domestic capabilities important to national security, particularly as China closes the technology gap with the US. To the extent that China becomes a leader in key technologies through indigenous innovation, excluding Chinese investment may further cede technological leadership.

This suggests a delicate balance between rejecting specific transactions that may pose national security risks while otherwise seeking to capitalise on the benefits of Chinese investment. A blanket ban on investments in entire sectors is unlikely to find this balance.

Ideas want to be free and new technologies will eventually diffuse across international borders. That is mostly for the better. It is unrealistic to expect that the world’s soon-to-be-largest economy will forever remain a technology laggard.

That is not to say that the US cannot maintain its technological leadership. Theft and autarky are a poor foundation on which to seek technological and economic progress. The main advantage the US has over China is not specific innovations that will be appropriated by foreigners, either legally or illegally, but the institutional framework that sustains their creation. That framework includes open capital markets, the rule of law and intellectual, political and cultural freedom.

That China relies heavily on appropriating foreign technology is itself evidence that it is struggling to compete in fostering institutions and a culture conducive to innovation and progress. The history of state-directed economic development is littered with costly failures and Made in China 2025 may well join them.

While many in the Trump Administration see China’s failure to fully play by international rules and norms as a weapon employed against the US, China’s selective adherence to these rules and norms is also a strategic weakness.

It helps explains why China has no allies apart from North Korea, a country that is more a problem to be managed than a strategic asset. The US, by contrast, enjoys a network of security and economic relationships with countries like Australia that increases its strategic weight, although this is an asset the current Administration seems determined to ignore.

China’s political and economic system is brittle and insecure. The same forces that diffuse technological innovation also promote ideas and aspirations that threaten the Chinese Communist Party’s rule.

The US should continue to play to its strengths, including open capital markets. Blanket restrictions on foreign investment may hinder the US as much as China.

Dr Stephen Kirchner is Program Director, Trade and Investment, United States Studies Centre at the University of Sydney.

Trump Administration Divided on Trade Policy

I have an op-ed in the AFR noting the contradictions in US international economic policy. Full text below the fold (may differ slightly from edited AFR version).

The joint United States-China communique on trade issues released over the weekend has been flagged by US Treasury Secretary Steven Mnuchin as a ceasefire in the trade war between the two economies.

Yet the communique suggests the two countries remain far apart on key issues. The statement contained little of substance and at best serves as a placeholder for further negotiations.

Perhaps the biggest stumbling block is the US insistence on trying to negotiate specific trade outcomes rather than over the rules of trade.

Ironically, this is pushing China even further in the direction of managed trade as it attempts to satisfy US demands. Complaints about Chinese mercantilism ring hollow when the US is pursuing a mercantilist policy of its own.

Media reports note that the US Agriculture Department is looking into how to expand production of key agricultural products that China could then buy in an eerie echo of communist central planning.

The key US demand that China reduce the size of its bilateral trade surplus by increasing purchases of US goods and services is unrealistic and makes no economic sense.

The trade balance is an arbitrary construct, calculated on the basis of goods crossing lines on a map, with little regard to the location of value-added or the associated cross-border investment that balances the overall economic relationship between the two economies.

Even if China were to somehow increase its purchases of US goods and services, the increased demand for US dollars to make those purchases would tend to put upward pressure on the US dollar foreign exchange rate, making the US less competitive.

An expansionary US fiscal policy is already inducing foreign capital inflows and putting upward pressure on the US dollar exchange rate, crowding-out US net exports.

This is one reason why the US Federal Reserve has little reason to fear expansionary fiscal policy. The US dollar will do much of the work of tightening monetary conditions.

The US current account deficit is ultimately the product of its own imbalance between domestic saving and investment.

As Australia learned from policy mistakes in the 1980s and 90s, a current account deficit and corresponding capital account surplus is an indication of economic strength, not weakness.

China’s former current account surplus, which turned to a deficit in the first quarter of this year, says more about the defects of its economy than its strengths, in particular, the suppression and distortion of its domestic capital markets.

US economic and trade policy under Trump are fundamentally incoherent. By all accounts, the US negotiating team is itself divided on key issues and China is at a loss to work out what the US wants and how to satisfy US demands.

At the same time that the US is looking to strike a superficial deal on managed trade with China, time is running out to re-negotiate the North American Free Trade Agreement (NAFTA). Having already walked away from another high quality trade agreement in the Trans-Pacific Partnership, the failure of the NAFTA negotiations would be another blow to the US economy as well as to US allies.

By focusing on specific outcomes on trade, the US is losing sight of the more important rules of the game that ensure trade and cross-border investment are conducted in a fair and reciprocal manner.

Donald Trump’s offer at the instigation of the Chinese to relax restrictions on Chinese telecoms company ZTE as part of the effort to secure Chinese concessions illustrates how attempts to manage trade internationally can undermine the rule of law domestically.

The rule of law is one of the great strengths of the US economy, the foundation stone of its capital markets and itself an important export to the rest of the world that consumes US financial services.

Even if China and the US were to flesh out their weekend communique with a more specific deal on trade, it is unlikely to prove robust to the inherently dynamic nature of the world economy.

Financial markets, including exchange rates, will effectively discount the substance of any agreement and the other incoherent elements of US economic policy.

The laws of economics will continue to work, even if President Trump does not believe in them.

The US Administration will find itself fighting a losing war against economic fundamentals. It will also find very few partners willing to enter into bilateral agreements to replace the multilateral agreements it has walked away from.

Those looking for a resolution of US and Chinese trade tensions in the weekend communique are sure to be disappointed. With the Trump Administration focused on arbitrary and economically irrelevant measures of trade performance, a lasting peace in its self-imposed trade war with the rest of the world will be impossible to achieve.

Dr Stephen Kirchner is Program Director, Trade and Investment, United States Studies Centre at the University of Sydney.

Trump pursuing the wrong strategy against China

I have an op-ed in the AFR arguing President Trump is pursuing the wrong trade policy strategy against China. Full text below the fold.

President Trump has proposed an additional $US 100 billion in tariffs on Chinese imports, on top of the 25 per cent tariffs on $US 50 billion of imports already mooted as retaliation for China’s forced technology transfers and intellectual property rights violations. The US has also initiated a WTO dispute with China over its increasingly discriminatory technology regulations.

The latest tariff measures are a response to genuine violations of international trade law by China, unlike the recent tariffs on steel and aluminium, which were based on a bad faith invocation of the national security provisions of US trade law.

However, the Administration’s proposed tariffs are the wrong remedy, inconsistent with its domestic and international legal obligations and will be ineffective in changing Chinese practices.

Instead of implementing new tariffs, the US should instead broaden its WTO dispute with China to cover the full range of intellectual property issues and discriminatory technology regulations.

Foreign firms operating in China have long complained about forced intellectual property transfer as a condition for entry into the Chinese market and as part of joint venture arrangements with Chinese firms.
China’s new National Cybersecurity Law and the National Security Law require that information, communications and technology (ICT) products must be “secure and controllable.” This vague standard provides a legal mechanism through which China can engage in ICT protectionism and extract trade secrets and intellectual property such as source code from foreign firms.

Foreign companies operating in China are subject to multiple security reviews administered by multiple agencies, including a new cybersecurity review regime. China is imposing data localisation requirements that potentially interfere with the ability of both foreign and Chinese firms to operate global ecommerce and other platforms.

China is also erecting barriers to competition in cloud computing, with foreign cloud service providers requiring a local partner.

These measures reflect China’s desire to control the internet and ICT goods as part of its apparatus of social and political repression, as well as to foster indigenous technological innovation through state intervention and protectionism. China seeks to become a global technology leader through self-sufficiency in the production and consumption of all technology goods and services. China’s mercantilist approach to technology innovation threatens to fragment the internet and ICT product development globally.

China’s ICT protectionism violates both the WTO Agreement on Trade Related Intellectual Property Rights and China’s WTO Accession Protocol. China is vulnerable to a WTO challenge over its intellectual property rights violations. Indeed, the US has previously brought successful WTO actions against China in this area which led China to voluntarily eliminate the offending practices.

The US could initiate a broader action at the WTO in concert with other countries with good prospects for success. The US and other countries supported China’s accession to the WTO in 2001 so they could exercise this leverage over China.

By pursuing unilateral tariff measures outside the WTO, the Trump Administration transforms the US from trade victim to trade villain. China is well within its rights to challenge the US measures as a violation of US obligations and impose proportionate retaliatory measures. The WTO could rule that the relevant provisions of US trade law are inconsistent with WTO rules, authorising Chinese retaliation, a perverse outcome.

Trump has engineered a situation in which China can turn the WTO against the United States over an issue where China is ultimately at fault.

Trump’s latest tariffs are also vulnerable to domestic legal challenge. The measures fall outside his legislative authority under section 301 of the Trade Act, which authorises the US Trade Representative (USTR) to take action only in respect of foreign trade barriers that fall outside the scope of WTO rules. US law requires the USTR to invoke WTO dispute settlement procedures where applicable. Trump is abusing both domestic and international law.

Unilateral tariffs by the United States are unlikely to change Chinese policy and China’s retaliatory tariffs will compound the self-inflicted harm to the US economy.

The US should instead be leading concerted action through the WTO to change Chinese policy and protect the internet and global ICT standards from further fragmentation at the hands of China.

The Trans-Pacific Partnership was potentially a vehicle through which the US could have enlisted other countries to pushback against China’s ICT protectionism and state-led capitalism, but US withdrawal from the TPP means that is now a missed opportunity.

It is incumbent upon the Republican-led Congress to reign in the Trump Administration’s anti-trade policies. There is historical precedent for Congress overturning Presidential tariff measures. Congress should go further and legislate to remove some of the President’s Cold War-era discretionary powers over trade policy.

If Congress does not act to reign in the Trump Presidency over trade, the damage that will be inflicted on the US and world economy will only compound that from China’s mercantilist policies.

Making America 1930 Again

I have an op-ed in the AFR on Trump’s latest tariff measures. Full text below the fold.

Steel tariffs make America 1930 again

The Trump Administration’s decision to impose global tariffs of 25% on imported steel and 10% on aluminium will come as a disappointment to Australia and other US allies who hoped to be carved out of the measures. While there may still be scope for Australian exports to be excluded from the tariffs, Trump has told US industry executives he wants no exceptions.

The tariffs are to be imposed under Section 232 of the US Trade Expansion Act of 1962, which authorises the Secretary of Commerce to investigate whether imports are harming US national security and to propose remedies to the President.

This provision was designed to guard against a situation in which the US might become dependent on unfriendly countries for imports critical to national security. It was last used by President Reagan in 1986.

Yet in the case of steel imports, there is no such dependence. Most US steel imports come from allies such as Canada, Europe, South Korea and Australia. China and Russia have a small share of overall imports. The defence sector consumes a trivial share of US domestic steel output. The measures will harm US allies more than its strategic competitors.

A stronger although still flawed national security case can be made for aluminium, where Russia and China have a larger share of imports. The US has only one aluminium smelter that produces aerospace-grade product.
But the aluminium tariff is much smaller than the steel tariff, so the proposed remedies are not proportional to the alleged threat. This suggests the real motivation is protectionism not national security.

As well as harming US allies, the tariffs will increase costs for the US defence sector. The measures as proposed were opposed by the Pentagon, in part because of the harm to US allies like Australia. The consumers of US steel across a wide range of industries and US exports will be hit. The tariffs will also increase the cost of President Trump’s proposed infrastructure program.

The measures are an abuse of US trade law. By all accounts, the Commerce Department’s investigation into the matter was perfunctory, with little regard for proper process. Trump has complete discretion over the form and duration of the measures. They are so sweeping it will almost certainly be necessary to introduce exclusions in future, from which Australia may or may not benefit.

Affected countries will retaliate and the measures could be the subject of disputes before the World Trade Organisation. Whether the WTO upholds the national security justification will be a key issue.

If it does, this will set a dangerous precedent for other countries to abuse similar provisions in domestic and international trade rules. If it does not, the Administration may ignore the WTO ruling or, worse, withdraw from the WTO. The latter outcome would be the biggest blow to the rules-based international trading system since the 1930s.

The WTO dispute settlement process is already being actively undermined by the Trump Administration, which is blocking appointments to the appellate body that adjudicates trade disputes.

The tariffs follow the safeguard measures imposed earlier this year on solar panels and washing machines. The Administration is also expected to pursue major retaliatory action in response to Chinese intellectual property rights violations. These measures will almost certainly violate WTO rules. If challenged by China, the WTO could rule against the US and declare the relevant provisions of US trade law inconsistent with WTO obligations.

Collectively, these actions amount to a massive assault on free trade that will harm the US economy more than other countries. It suggests the anti-free trade forces in Trump’s Administration are in the ascendant. The adverse financial market reaction to the latest tariffs only hints at the damage that could be done to the world economy.

While some in the Administration continue to hold the door open to the US re-joining the Trans-Pacific Partnership, as the Australian government hopes, Trump’s policy actions demonstrate this is an increasingly remote prospect.

While Australia will be disappointed with the latest tariffs, it does not come to this issue with clean hands. Australia is an increasingly aggressive user of anti-dumping actions, including duties on steel imports. Ironically, Australian producers are now being hit by these duties as they need to import product to meet demand in excess of domestic production.

Changes to Australia’s anti-dumping regime under the Abbott and Turnbull governments have made it easier for local producers to abuse the anti-dumping system for protectionist purposes.
Successive Australian governments have ignored advice going back as far as the 1989 Garnaut Report that they should abandon or curtail the use of anti-dumping measures.

Australia’s lobbying effort on US steel tariffs might have resonated more strongly in Washington if we were not also playing the protectionist game.

Dr Stephen Kirchner is Program Director, Trade and Investment, United States Studies Centre at the University of Sydney.